Insider trading laws
Craig Turner, 20241003
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This Carto Institute piece argues against Insider Trading laws,

    https://www.cato.org/blog/should-insider-trading-be-legal

    (It is a short paper, and I recommend reading it before continuing to read
    this note.)

I have worked on equities platforms in the US and Europe, and write to defend
the current developed-economy practice of banning insider trading.

The paper highlights and then criticises some arguments that are commonly used
to support laws that bad insider trading.

I don't think the criticism holds up, and consider the named arguments to be
valid. In detail,

    1. "critics of insider trading argue that it violates the principle of
    equal opportunity because actors are trading on information available only
    to them"

        This is true - such activity does undermine the principle of equal
        opportunity.

        The argument the author makes later about hedge funds is not relevant
        to this, because they are building their conclusions from a foundation
        of public information.

    2. "[insider trading] creates inefficiencies by discouraging investment".

        Insider trading does discourage investment.

        The equities market only exists because of the combination of the
        heavy regulation that creates it, and the public that chooses to
        invest in it.

        The equities market will only retain public confidence while people
        have high confidence in the utility value of the system. This is an
        ongoing project, akin to regularly painting a house to protect the
        walls.

        Allowing insider trading would undermine that project, because it
        would rightfully strengthen the perception that there was one standard
        for insiders and another for outsiders.

I will present two further arguments.

    3. Work related to employment should focus on service to the company. If
    people are trading on the back of information they access through
    employment, that creates mixed incentives.

    4. Laws around equities trading expect participants to act in good faith.
    Consider rules against front-running, rules about not loading up the book
    to communicate false interest. The ban on insider trading fits naturally
    into the ethos of the larger set of rules. It would be weird to create an
    exception for that alone.

The Cato Institute post presents some interesting notes about what a world
without insider trading bans would look like,

    a. More efficient price-discovery. This is true.

    b. Non-government mechanisms where firms prevent insider trading. A firm
    could build a reputation for being good at this, and distinguish
    themselves against the market.

Although the second point is true, it creates a far more complicated market
structure. Pricing of equities would need to consider how individual companies
enforce the behaviour of their staff.

Perhaps this would evolve into an industry standard akin to SOC 2 Type 2.
Yuck! It is simpler and more efficient to have the regulator outlaw insider
trading.

Most markets emerge organically. Food stalls, shoe shops, commodities, foreign
exchange. But this is not true of the equities market.

The equities market as we currently think of it is a product of heavy
government regulation. Without that regulation, the market would not exist.
The concept of a shared-stock public company would have been discredited due
to gaming by bad faith in its early history, and would be a footnote holding
interest only to historians.

There is no such thing as a big equities market without heavy regulation. If a
country tried to build such a thing, it would not win public confidence. If
the US tried to change its system to that model, liquidity would flow away to
other jurisdictions. Note that this kind of jurisdiction competition drove
Hong Kong and France [1] to create insider trading bans.

The dynamics of insider trading and public confidence are a reason to be
dubious about the prospects of some proposals for blockchain-based securities.


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:1 See p46/47 of https://repository.law.miami.edu/cgi/viewcontent.cgi?article=1503&context=umialr